After a spectacular rise this year for the major equity indexes, we have experienced a correction in August. This begs the question: Why?
I have several theories, which I believe have all contributed in some part to the August pullback. They are as follows:
- Fitch Downgrading of US Government Debt – this came during Track Week. However, it also came about twelve years too late after Standard & Poor’s downgraded the US Debt from AAA to AA+ on August 5, 2011. Nevertheless, Fitch’s action put the first major ding in the markets.
- More Fear of Fed – despite evidence pointing toward the Federal Reserve Open Market Committee’s (FOMC) cessation of its tightening cycle, the FOMC meeting minutes indicated that there was not unanimity amongst the voting members and that more rate hikes could occur this year. Essentially, there is certainty that uncertainty prevails at the FOMC.
- Chinese Economic Growth is Collapsing – the second largest economy in the world is suffering from declining consumer demand and a weak housing market. The greater concern is that this economic slowdown can rollover into the United States and Europe. China is going to have to begin to lower lending rates and focus its Communist / Mercantilist efforts at home rather than abroad.
- US Treasury Rates – The yields on US Treasury debt securities are rising. You can argue that is in part due to the Fitch downgrade. You can also argue that the inverted yield curve (where longer-term yields are less than shorter term yields) indicates that a recession is on the horizon. I would state that more and more analysts who were forecasting a recession in the US this or next year are reversing their opinion. I am on the record stating that I did not expect a coast-to-coast recession in the United States but rather a rolling regional and sector weakness. Lastly, for the first time in many years, yields on US Treasuries are competitive with stocks. I am going to speculate that the PRC (China) is selling US Government securities to raise cash to prop up its economy. This causes a lowering of prices and rising yields.
- 70/30, 60/40 and Target Maturity Fund Pain- Bonds are experiencing a bear market with holders of longer-term debt (say ten years or more in maturity) feeling pain. Many of the popular mutual funds with 60% stock / 40% bond, 70% stock / 30% bond or targeted maturity funds are getting hit hard in the bond component of their portfolios. This is even truer for corporate bonds than US Treasury securities. This forces the fund managers to rebalance by selling stock and buying bonds. I am anti-mutual funds, especially those that contain bonds. My preference for more mildly conservative clients is to have some balance between growth and dividend stocks. This has proved to be a successful strategy.
- Energy Prices are Surging Again – crude oil prices in the last thirty days surged over $6 or 7% per gallon. That of course translates into higher prices at the pump during the summer driving season and energy prices at home. Headline inflation rates are coming down, but that data excludes food and energy prices, hence aggregate inflation is more than the Federal Government leads you to believe. Next time I publish, I am going to provide a discourse on inflation.
- Option Activity – there are two phenomena in the options markets which are worth noting. First is that put activity (bets that stocks will decline) are greater than those for calls (bets that stocks will rise), which put together, we refer to as the Put/Call Ratio. That ratio was favoring Puts which means that market participants were buying insurance against a market decline. However, it also tends to be a contrarian indictor which means that a market bottom and turnaround is in the cards. The second phenomenon is the proliferation of same day options referred to as 0DTE options. Normally options expire anywhere from a week to years in the future. Same day options have a life of one trading day and may have been the source of those late day market swoons last week. Being an expert in options and derivatives, I must opine that same day options are the most insidious concept ever to hit the financial markets since credit default swaps. Already I am hearing that the SEC (Securities and Exchange Commission) is taking a hard look at these products.
- Markets Were Overextended – simply put, we were due for a normal pullback.
This week there are two interesting events which market participants will be focused on:
- On Wednesday, after the market closes, trillion-dollar semiconductor manufacturer Nvidia (NVDA) will be reporting results for its second quarter. Last time NVDA reported results the company surprised Wall Street with greater than expected results and strong guidance based on surging demand for AI (Artificial Intelligence) chips. The bar is set high, but another beat could put some tailwinds back into NVDA and technology stocks after its nearly 10% pullback since last reporting.
- FOMC Chairman Jerome Powell will be speaking at the Jackson Hole WY Economic Symposium. It’s the summertime version of the Davos winter economic boondoggle. Last year Powell put a dagger into the heart of the financial markets when talking at Jackson Hole. This year ears will be turned into his forecast for future FOMC action and inflation. Any hawkish commentary will be further reasons for markets to sell off, while dovish language will quell market anxiety.
Disclosure: At the time of this commentary Scott Rothbort, his family and/or clients of LakeView Asset Management, LLC was long - although positions can change at any time.
Scott Rothbort is the President & Founder of LakeView Asset Management, LLC, (LVAM) an investment advisor representative, specializing in high net worth private wealth management. LVAM is affiliated with Kingswood Wealth Advisors Services, a registered investment advisor. For more information on investing with LakeView Asset Management, LLC call us at 888-9LAKEVIEW or request more information by clicking on the contact button on the top right-hand corner of the website. LakeView Management, LLC is a Nevada LLC, with its principal office located in Henderson, NV and branch office located in Millburn, NJ
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